My wife called me and said, “Mrs. Jones just called me and said that her knee hurts and that she wants our insurance information”.
“Who is Mrs. Jones?” I said.
My wife, “The lady that walked through Loon Dr. last week”, which is a house that we had just acquired and put up for rent.
When you are successful, people will see that. It is an unfortunate part of our culture such that anyone can sue anyone for anything. We are good at covering and protecting ourselves. Mrs. Jones realized quickly that we weren’t an easy target and quickly withdrew her concerns about our insurance. I guess her knee didn’t really hurt that bad after all.
This is written to make you think long term. This is to provide information and should not be considered as advice. I highly recommend speaking with your CPA and local real estate attorney when choosing the best structure and protection for your business.
When new investors begin buying, selling, flipping, or even landlording, they typically don’t think about the long-term investment and long-term risk associated with doing a high volume of transactions. They think about the next purchase or the next deal. We teach our clients to build their business like they are going to have millions. Unfortunately, if you have millions that also means that you have millions to lose. I read a statistic that said 94% of the worldwide lawsuits are filed here in the U.S. Statistically speaking, at some point in your investing career, you may face some litigation, regardless of merit.
I was taught early on to set up the business to protect it from frivolous lawsuits. Keep in mind that anyone can sue anyone for anything in the U.S. That being said, you want to protect your assets so that the judge, or whoever, throws out the case and awards you the attorney fees. You want to make your business an unattractive target for opposing attorneys to file a lawsuit. At the end of the day, if an attorney can’t get paid, they are less likely to take the case and come after you or your business.
There are many ways that you can set up your business, and I'll cover a few.
1) LLC/S-Corp-As I mentioned in the beginning few chapters, there are different types of entities. Entities are essential because the entity is separate from the investor. The investor owns the entity, but the investor is not the entity. For example, John Smith starts up Smith Homes, LLC. Let’s say that Smith Homes, LLC. buys a property at 123 Main St. John Smith doesn’t own the property, but his business does. Therefore, in most cases, any issues or concerns with 123 Main St. are the concern of Smith Homes, LLC. and not directly of John Smith.
The separation of person and entity is crucial for so many reasons. In the example above, if a person wanted to sue Smith Homes, LLC., because of a slip and fall at 123 Main St., John Smith and his personal assets should be protected and should not be part of any litigation. However, if John Smith had bought the home in his name and not in an entity, then John Smith and all his personal assets may be at risk.
2) Trusts-I’ve spoken with many attorneys and, depending on their specialty, they may or may not understand the legal protection that a trust offers. Anyone, not just an investor, can use a trust. In real estate, a trust is often used as an estate planning tool. A trust is usually comprised of 3 parties: Trustor, Trustee, and Beneficiary. Please consult your attorney for further details on the roles and responsibilities of each.
Many investors will put each of their properties in a trust, or each property may be placed into their own separate trust. Many investors will put their entities in a trust. Many investors may put their personal assets in a trust. There are options and reasons behind doing so. Again, consult your attorney.
3) Umbrella Insurance Policy-Some investors, to simplify their processes, accounting, etc., will purchase all their properties and run their business through their names. Yes, they are at risk; however, they will take out a large umbrella insurance policy that is valued at more than the sum of their properties. For example, John Smith owns 20 houses free and clear that are valued at $4,000,000. The investor may take out an umbrella insurance policy of $6,000,000 to cover the investment assets and his personal and family assets.
These are just three strategies that are commonly used. An investor may use a combination of the three. Keep in mind that each offers different protections and may have different tax implications. For more in-depth information on asset protection, I highly recommend reading, "A Practical Guide to Asset Protection” by Bud Lethbridge, Blair Jackson, M.A., J.D., and G. James Christiansen, J.D. I met Mr. Lethbridge in Utah. His research and attention to detail were more than impressive. He owns a company called Veil Corporate in Utah that anyone can call for more information and assistance.
If you have something valuable, protect it. They say, it is not if you are going to get sued, but when will you get sued. Protect your family, yourself, and your business. Don’t take the risk and try to save $500 on the forming of your entity. Hire a professional to do it the right way. Spend the money upfront or potentially lose thousands or millions down the road.
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